Table Of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

 

FORM 10-Q

 

(Mark One)

( X )	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
	OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the Quarterly Period Ended March 31, 2015

 

OR

 

(   )	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
	OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from                    to_________

 

Commission File Number 0-25923

 

Eagle Bancorp, Inc.

(Exact name of registrant as specified in its charter)

 

Maryland	52-2061461
(State or other jurisdiction of	(I.R.S. Employer
incorporation or organization)	Identification No.)
7830 Old Georgetown Road, Third Floor, Bethesda, Maryland	20814
Address of principal executive offices	(Zip Code)

       

(301) 986-1800

(Registrant's telephone number, including area code)

(Former name, former address and former fiscal year, if changed since last report)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒No ☐

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes☒ No ☐

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definition of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer ☒

Accelerated filer ☐

Non-accelerated filer ☐

Smaller Reporting Company ☐

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act

Yes ☐     No ☒

 

Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date.

 

As of April 23, 2015, the registrant had 33,359,716 shares of Common Stock outstanding.

 

  

EAGLE BANCORP, INC.

TABLE OF CONTENTS

 

PART I.	FINANCIAL INFORMATION
Item 1.	Financial Statements (Unaudited)		3
	Consolidated Balance Sheets		3
	Consolidated Statements of Operations		4
	Consolidated Statements of Comprehensive Income		5
	Consolidated Statements of Changes in Shareholders’ Equity		6
	Consolidated Statements of Cash Flows		7
	Notes to Consolidated Financial Statements		8
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		39
Item 3.	Quantitative and Qualitative Disclosures About Market Risk		66
Item 4.	Controls and Procedures		66
PART II.	OTHER INFORMATION		67
Item 1.	Legal Proceedings		67
Item 1A.	Risk Factors		67
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds		67
Item 3.	Defaults Upon Senior Securities		67
Item 4.	Mine Safety Disclosures		67
Item 5.	Other Information		67
Item 6.	Exhibits		67
Signatures			70

 

 

Item 1 – Financial Statements (Unaudited)

---

 

EAGLE BANCORP, INC.

Consolidated Balance Sheets (Unaudited)

(dollars in thousands, except per share data)

 

		March 31, 2015				December 31, 2014				March 31, 2014
Assets
Cash and due from banks		$	9,997			$	9,097			$	8,982
Federal funds sold			2,700				3,516				8,468
Interest bearing deposits with banks and other short-term investments			402,964				243,412				213,501
Investment securities available for sale, at fair value			333,531				382,343				387,790
Federal Reserve and Federal Home Loan Bank stock			16,793				22,560				10,599
Loans held for sale			62,758				44,317				21,862
Loans			4,444,893				4,312,399				3,063,975
Less allowance for credit losses			(47,779	)			(46,075	)			(42,018	)
Loans, net			4,397,114				4,266,324				3,021,957
Premises and equipment, net			18,185				19,099				17,181
Deferred income taxes			32,089				32,511				27,146
Bank owned life insurance			56,983				56,594				40,052
Intangible assets, net			109,617				109,908				3,482
Other real estate owned			12,338				13,224				8,809
Other assets			45,271				44,975				34,123
Total Assets		$	5,500,340			$	5,247,880			$	3,803,952
Liabilities and Shareholders' Equity
Liabilities
Deposits:
Noninterest bearing demand		$	1,196,165			$	1,175,799			$	886,623
Interest bearing transaction			178,291				143,628				106,645
Savings and money market			2,405,435				2,302,600				1,861,355
Time, $100,000 or more			412,691				393,132				196,238
Other time			391,783				295,609				222,828
Total deposits			4,584,365				4,310,768				3,273,689
Customer repurchase agreements			58,589				61,120				66,437
Other short-term borrowings			-				100,000				-
Long-term borrowings			79,300				119,300				39,300
Other liabilities			36,556				35,933				14,144
Total Liabilities			4,758,810				4,627,121				3,393,570
Shareholders' Equity
Preferred stock, par value $.01 per share, shares authorized 1,000,000, Series B, $1,000 per share liquidation preference, shares issued andoutstanding 56,600 at March 31, 2015, December 31, 2014 and March 31, 2014; Series C, $1,000 per share liquidation preference, shares issued and outstanding 15,300 at March 31, 2015, December 31, 2014 and -0- at March 31, 2014			71,900				71,900				56,600
Common stock, par value $.01 per share; shares authorized 50,000,000, shares issued and outstanding 33,303,467, 30,139,396 and 25,975,186 respectively			329				296				255
Warrant			946				946				946
Additional paid in capital			495,784				394,933				244,332
Retained earnings			169,291				150,037				108,751
Accumulated other comprehensive income (loss)			3,280				2,647				(502	)
Total Shareholders' Equity			741,530				620,759				410,382
Total Liabilities and Shareholders' Equity		$	5,500,340			$	5,247,880			$	3,803,952

 

See notes to consolidated financial statements.

 

  

EAGLE BANCORP, INC.

Consolidated Statements of Operations (Unaudited)

(dollars in thousands, except per share data)

 

		Three Months Ended March 31,
		2015				2014
Interest Income
Interest and fees on loans		$	57,179			$	40,363
Interest and dividends on investment securities			2,139				2,333
Interest on balances with other banks and short-term investments			138				138
Interest on federal funds sold			9				3
Total interest income			59,465				42,837
Interest Expense
Interest on deposits			3,242				2,412
Interest on customer repurchase agreements			27				38
Interest on short-term borrowings			54				-
Interest on long-term borrowings			1,411				380
Total interest expense			4,734				2,830
Net Interest Income			54,731				40,007
Provision for Credit Losses			3,310				1,934
Net Interest Income After Provision For Credit Losses			51,421				38,073
Noninterest Income
Service charges on deposits			1,333				1,192
Gain on sale of loans			3,587				1,843
Gain on sale of investment securities			2,164				8
Loss on early extinguishment of debt			(1,130	)			-
Increase in the cash surrender value of bank owned life insurance			390				314
Other income			1,460				1,106
Total noninterest income			7,804				4,463
Noninterest Expense
Salaries and employee benefits			15,706				13,608
Premises and equipment expenses			4,010				3,089
Marketing and advertising			685				462
Data processing			1,784				1,588
Legal, accounting and professional fees			982				974
FDIC insurance			771				544
Merger expenses			111				-
Other expenses			4,024				2,833
Total noninterest expense			28,073				23,098
Income Before Income Tax Expense			31,152				19,438
Income Tax Expense			11,734				6,939
Net Income			19,418				12,499
Preferred Stock Dividends			180				141
Net Income Available to Common Shareholders		$	19,238			$	12,358
Earnings Per Common Share
Basic		$	0.62			$	0.48
Diluted		$	0.61			$	0.47

 

See notes to consolidated financial statements.

 

 

EAGLE BANCORP, INC.

Consolidated Statements of Comprehensive Income (Unaudited)

(dollars in thousands)

 

		Three Months Ended March 31,
		2015				2014
Net Income		$	19,418			$	12,499
Other comprehensive income (loss), net of tax:
Net unrealized gain (loss) on securities available for sale			1,931				2,822
Reclassification adjustment for net gains included in net income			(1,298	)			(5	)
Net change in unrealized (loss) gains on securities			633				2,817
Comprehensive Income		$	20,051			$	15,316

 

See notes to consolidated financial statements.

 

 

EAGLE BANCORP, INC.

Consolidated Statements of Changes in Shareholders’ Equity (Unaudited)

(dollars in thousands except share data)

 

																										Accumulated
		Preferred								Common												Additional Paid				Other Retained				Total Comprehensive				Total Shareholders'
		Shares				Stock				Shares				Stock				Warrant				in Capital				Earnings				Income (Loss)				Equity
Balance January 1, 2015			71,900			$	71,900				30,139,396			$	296			$	946			$	394,933			$	150,037			$	2,647			$	620,759
Net Income			-				-				-				-				-				-				19,418				-				19,418
Net change in other comprehensive income, net of tax			-				-				-				-				-				-				-				633				633
Stock-based compensation			-				-				-				-				-				1,148				-				-				1,148
Issuance of common stock related to options exercised			-				-				279,373				3				-				3,435				-				-				3,438
Tax benefit on non-qualified options exercised			-				-				-				-				-				1,450				-				-				1,450
Issuance of common stock upon vesting of restricted stock awards, net of shares withheld for payroll taxes			-				-				(15,039	)			2				-				(2	)			-				-				-
Restricted stock awards granted			-				-				78,070				-				-				-				-				-				-
Shares issued in public offering, net of issuance costs of $5,302			-				-				2,816,900				28				-				94,670				-				-				94,698
Issuance of common stock related to employee stock purchase plan			-				-				4,767				-				-				154				-				-				154
Cash paid in lieu of fractional shares upon merger with Virginia Heritage			-				-				-				-				-				(4	)			-				-				(4	)
Preferred stock dividends			-				-				-				-				-				-				(164	)			-				(164	)
Balance March 31, 2015			71,900			$	71,900				33,303,467			$	329			$	946			$	495,784			$	169,291			$	3,280			$	741,530
Balance January 1, 2014			56,600			$	56,600				25,885,863			$	253			$	946			$	242,990			$	96,393			$	(3,319	)		$	393,863
Net Income			-				-				-				-				-				-				12,499				-				12,499
Net change in other comprehensive income, net of tax			-				-				-				-				-				-				-				2,817				2,817
Stock-based compensation			-				-				-				-				-				892				-				-				892
Issuance of common stock related to options exercised			-				-				19,027				-				-				250				-				-				250
Tax benefit on non-qualified options exercised			-				-				-				-				-				75				-				-				75
Issuance of common stock upon vesting of restricted stock awards, net of shares withheld for payroll taxes			-				-				(13,110	)			2				-				(2	)			-				-				-
Restricted stock awards granted			-				-				78,947				-				-				-				-				-				-
Issuance of common stock related to employee stock purchase plan			-				-				4,459				-				-				127				-				-				127
Preferred stock dividends			-				-				-				-				-				-				(141	)			-				(141	)
Balance March 31, 2014			56,600			$	56,600				25,975,186			$	255			$	946			$	244,332			$	108,751			$	(502	)		$	410,382

 

See notes to consolidated financial statements.

  

 

EAGLE BANCORP, INC.

Consolidated Statements of Cash Flows (Unaudited)

(dollars in thousands)

 

		Three Months Ended March 31,
		2015				2014
Cash Flows From Operating Activities:
Net Income		$	19,418			$	12,499
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for credit losses			3,310				1,934
Depreciation and amortization			2,931				1,119
Gains on sale of loans			(3,587	)			(1,843	)
Securities premium amortization (discount accretion), net			683				861
Origination of loans held for sale			(279,612	)			(98,321	)
Proceeds from sale of loans held for sale			264,758				120,332
Net increase in cash surrender value of BOLI			(390	)			(314	)
Decrease in deferred income taxes			422				1,803
Decrease in fair value of other real estate owned			750				453
Net loss on sale of other real estate owned			17				100
Net gain on sale of investment securities			(2,164	)			(8	)
Loss on early extinguishment of debt			1,130				-
Stock-based compensation expense			1,148				892
Excess tax benefits from stock-based compensation			(1,450	)			(75	)
Increase in other assets			(296	)			(3,411	)
Increase (decrease) in other liabilities			623				(18,311	)
Net cash provided by operating activities			7,691				17,710
Cash Flows From Investing Activities:
Decrease (increase) in interest bearing deposits with other banks and short-term investments			295				(5	)
Purchases of available for sale investment securities			(26,885	)			(18,564	)
Proceeds from maturities of available for sale securities			12,110				4,384
Proceeds from sale/call of available for sale securities			65,701				6,487
Purchases of Federal Reserve and Federal Home Loan Bank stock			(2,322	)			(26	)
Proceeds from redemption of Federal Reserve and Federal Home Loan Bank stock			8,100				699
Net increase in loans			(134,100	)			(119,871	)
Proceeds from sale of other real estate owned			153				108
Purchases of BOLI			(389	)			-
Purchases of annuities			(992	)			-
Bank premises and equipment acquired			(348	)			(1,483	)
Net cash used in investing activities			(78,677	)			(128,271	)
Cash Flows From Financing Activities:
Increase in deposits			273,597				48,275
Decrease in customer repurchase agreements			(2,531	)			(14,034	)
Issuance of common stock			94,698				-
Decrease in short-term borrowings			(100,000	)			-
Decrease in long-term borrowings			(40,000	)			-
Payment of dividends on preferred stock			(164	)			(141	)
Proceeds from exercise of stock options			3,439				250
Excess tax benefits from stock-based compensation			1,450				75
Payment in lieu of fractional shares			(4	)			-
Proceeds from employee stock purchase plan			153				127
Net cash provided by financing activities			230,622				34,552
Net Increase (Decrease) In Cash and Cash Equivalents			159,636				(76,009	)
Cash and Cash Equivalents at Beginning of Period			256,025				306,960
Cash and Cash Equivalents at End of Period		$	415,661			$	230,951
Supplemental Cash Flows Information:
Interest paid		$	6,045			$	3,022
Income taxes paid		$	8,350			$	7,550
Non-Cash Investing Activities
Transfers from loans to other real estate owned		$	-			$	245

 

See notes to consolidated financial statements.

 

 

EAGLE BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

 

Note 1. Summary of Significant Accounting Policies

 

Basis of Presentation

 

The consolidated financial statements include the accounts of Eagle Bancorp, Inc. and its subsidiaries (the “Company”), EagleBank (the “Bank”), Eagle Commercial Ventures, LLC (“ECV”), Eagle Insurance Services, LLC, and Bethesda Leasing, LLC, with all significant intercompany transactions eliminated.

 

The consolidated financial statements of the Company included herein are unaudited. The consolidated financial statements reflect all adjustments, consisting of normal recurring accruals that in the opinion of management, are necessary to present fairly the results for the periods presented. The amounts as of and for the year ended December 31, 2014 were derived from audited consolidated financial statements. Certain information and note disclosures normally included in financial statements prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission. There have been no significant changes to the Company’s Accounting Policies as disclosed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2014. The Company believes that the disclosures are adequate to make the information presented not misleading. Certain reclassifications have been made to amounts previously reported to conform to the current period presentation.

 

These statements should be read in conjunction with the audited consolidated financial statements and related notes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2014. Operating results for the three months ended March 31, 2015 are not necessarily indicative of the results of operations to be expected for the remainder of the year, or for any other period.

 

Nature of Operations

 

The Company, through the Bank, conducts a full service community banking business, primarily in Northern Virginia, Montgomery County, Maryland, and Washington, D.C. The primary financial services offered by the Bank include real estate, commercial and consumer lending, as well as traditional deposit and repurchase agreement products. The Bank is also active in the origination and sale of residential mortgage loans and the origination of small business loans. The guaranteed portion of small business loans, guaranteed by the Small Business Administration (“SBA”), is typically sold to third party investors in a transaction apart from the loan’s origination. As of March 31, 2015, the Bank offers its products and services through twenty two banking offices, four lending centers and various electronic capabilities, including remote deposit services and mobile banking services. Eagle Insurance Services, LLC, a subsidiary of the Bank, offers access to insurance products and services through a referral program with a third party insurance broker. Eagle Commercial Ventures, LLC, a direct subsidiary of the Company, provides subordinated financing for the acquisition, development and construction of real estate projects. These transactions involve higher levels of risk, together with commensurate higher returns. Refer to Higher Risk Lending – Revenue Recognition below.

 

Business Combinations

 

Business combinations are accounted for by applying the acquisition method in accordance with Accounting Standards Codification (“ASC”) 805, “Business Combinations.” Under the acquisition method, identifiable assets acquired and liabilities assumed, and any non-controlling interest in the acquiree at the acquisition date are measured at their fair values as of that date, and are recognized separately from goodwill. Results of operations of the acquired entities are included in the consolidated statement of income from the date of acquisition.

 

 

On October 31, 2014, the Company completed its acquisition of Virginia Heritage Bank (“Virginia Heritage”). The acquisition of Virginia Heritage was effected through the merger (the “Merger”) of Virginia Heritage with and into EagleBank, in accordance with the Agreement and Plan of Reorganization (the “Merger Agreement”) among the Company, EagleBank and Virginia Heritage, dated June 9, 2014. The acquisition added approximately $800 million in loans, $3 million in loans held for sale, $645 million in deposits, and $95 million in borrowings. An identified intangible related to core deposits was recorded for $4.6 million, which is being amortized over its estimated useful life of approximately 6 years and an initial intangible for goodwill was recorded for approximately $102.3 million. Additionally, in connection with the transaction, the Company recorded a fair value credit mark on the loan portfolio for approximately $12.5 million.

 

Use of Estimates

 

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts in the financial statements and accompanying notes. Actual results may differ from those estimates and such differences could be material to the financial statements.

 

Cash Flows

 

For purposes of reporting cash flows, cash and cash equivalents include cash and due from banks, federal funds sold, and interest bearing deposits with other banks which have an original maturity of three months or less.

 

Loans Held for Sale

 

The Company engages in sales of residential mortgage loans and the guaranteed portion of SBA loans originated by the Bank. Loans held for sale are carried at the lower of aggregate cost or fair value. Fair value is derived from secondary market quotations for similar instruments. Gains and losses on sales of these loans are recorded as a component of noninterest income in the consolidated statements of operations.

 

The Company’s current practice is to sell residential mortgage loans on a servicing released basis, and, therefore, it has no intangible asset recorded for the value of such servicing as of March 31, 2015, December 31, 2014 and March 31, 2014. The sale of the guaranteed portion of SBA loans on a servicing retained basis gives rise to an Excess Servicing Asset, which is computed on a loan by loan basis with the unamortized amount being included in Intangible assets in the consolidated balance sheets. This Excess Servicing Asset is being amortized on a straight-line basis (with adjustment for prepayments) as an offset to servicing fees collected and is included in Other income in the consolidated statement of operations.

 

The Company enters into commitments to originate residential mortgage loans whereby the interest rate on the loan is determined prior to funding (i.e. interest rate lock commitments). Such interest rate lock commitments on mortgage loans to be sold in the secondary market are considered to be derivatives. To protect against the price risk inherent in residential mortgage loan commitments, the Company utilizes both “best efforts” and “mandatory delivery” forward loan sale commitments to mitigate the risk of potential decreases in the values of loans that would result from the exercise of the derivative loan commitments. Under a “best efforts” contract, the Company commits to deliver an individual mortgage loan of a specified principal amount and quality to an investor and the investor commits to a price that it will purchase the loan from the Company if the loan to the underlying borrower closes. The Company protects itself from changes in interest rates through the use of best efforts forward delivery commitments, whereby the investor commits to purchase a loan at a price representing a premium on the day the borrower commits to an interest rate with the intent that the buyer/investor has assumed the interest rate risk on the loan. As a result, the Company is not generally exposed to losses on loans sold utilizing best efforts. Nor will it realize gains related to interest rate lock commitments due to changes in interest rates. The market values of interest rate lock commitments and best efforts contracts are not readily ascertainable with precision because interest rate lock commitments and best efforts contracts are not actively traded. Because of the high correlation between interest rate lock commitments and best efforts contracts, no gain or loss should occur on the interest rate lock commitments. Under a “mandatory delivery” contract, the Company commits to deliver a certain principal amount of mortgage loans to an investor at a specified price on or before a specified date. If the Company fails to deliver the amount of mortgages necessary to fulfill the commitment by the specified date, it is obligated to pay the investor a “pair-off” fee, based on then-current market prices, to compensate the investor for the shortfall. The interest rate lock commitments on mortgage loans to be sold in the secondary market are considered to be derivatives. The Company manages the interest rate risk on interest rate lock commitments by entering into forward sale contracts of mortgage backed securities, whereby the Company obtains the right to deliver securities to investors in the future at a specified price. Such contracts are accounted for as derivatives and are recorded at fair value in derivative assets or liabilities, with changes in fair value recorded in other income. The period of time between issuance of a loan commitment to the customer and closing and sale of the loan to an investor generally ranges from 30 to 90 days under current market conditions.

 

 

In circumstances where the Company does not deliver the whole loan to an investor, but rather elects to retain the loan in its portfolio, the loan is transferred from held for sale at fair value.

 

Investment Securities

 

The Company has no securities classified as trading, or as held to maturity. Marketable equity securities and debt securities not classified as held to maturity or trading are classified as available-for-sale. Securities available-for-sale are acquired as part of the Company’s asset/liability management strategy and may be sold in response to changes in interest rates, current market conditions, loan demand, changes in prepayment risk and other factors. Securities available-for-sale are carried at fair value, with unrealized gains or losses being reported as accumulated other comprehensive income/(loss), a separate component of shareholders’ equity, net of deferred income tax. Realized gains and losses, using the specific identification method, are included as a separate component of noninterest income in the consolidated statements of operations.

 

Premiums and discounts on investment securities are amortized / accreted to the earlier of call or maturity based on expected lives, which lives are adjusted based on prepayment assumptions and call optionality if any. Declines in the fair value of individual available-for-sale securities below their cost that are other-than-temporary in nature result in write-downs of the individual securities to their fair value. Factors affecting the determination of whether other-than-temporary impairment has occurred include a downgrading of the security by a rating agency, a significant deterioration in the financial condition of the issuer, or a change in management’s intent and ability to hold a security for a period of time sufficient to allow for any anticipated recovery in fair value. Management systematically evaluates investment securities for other-than-temporary declines in fair value on a quarterly basis. This analysis requires management to consider various factors, which include (1) duration and magnitude of the decline in value, (2) the financial condition of the issuer or issuers and (3) structure of the security.

 

The entire amount of an impairment loss is recognized in earnings only when (1) the Company intends to sell the security, or (2) it is more likely than not that the Company will have to sell the security before recovery of its amortized cost basis, or (3) the Company does not expect to recover the entire amortized cost basis of the security. In all other situations, only the portion of the impairment loss representing the credit loss must be recognized in earnings, with the remaining portion being recognized in shareholders’ equity as comprehensive income, net of deferred taxes.

 

Loans

 

Loans are stated at the principal amount outstanding, net of unamortized deferred costs and fees. Interest income on loans is accrued at the contractual rate on the principal amount outstanding. It is the Company’s policy to discontinue the accrual of interest when circumstances indicate that collection is doubtful. Deferred fees and costs are being amortized on the interest method over the term of the loan.

 

Management considers loans impaired when, based on current information, it is probable that the Company will not collect all principal and interest payments according to contractual terms. Loans are evaluated for impairment in accordance with the Company’s portfolio monitoring and ongoing risk assessment procedures.  Management considers the financial condition of the borrower, cash flow of the borrower, payment status of the loan, and the value of the collateral, if any, securing the loan. Generally, impaired loans do not include large groups of smaller balance homogeneous loans such as residential real estate and consumer type loans which are evaluated collectively for impairment and are generally placed on nonaccrual when the loan becomes 90 days past due as to principal or interest. Loans specifically reviewed for impairment are not considered impaired during periods of “minimal delay” in payment (ninety days or less) provided eventual collection of all amounts due is expected.  The impairment of a loan is measured based on the present value of expected future cash flows discounted at the loan’s effective interest rate, or the fair value of the collateral if repayment is expected to be provided solely by the collateral.  In appropriate circumstances, interest income on impaired loans may be recognized on a cash basis.

 

 

Higher Risk Lending – Revenue Recognition

 

The Company has occasionally made higher risk acquisition, development, and construction (“ADC”) loans that entail higher risks than ADC loans made following normal underwriting practices (“higher risk loan transactions”). These higher risk loan transactions are currently made through the Company’s subsidiary, ECV. This activity is limited as to individual transaction amount and total exposure amounts, based on capital levels, and is carefully monitored. The loans are carried on the balance sheet at amounts outstanding and meet the loan classification requirements of the Accounting Standard Executive Committee (“AcSEC”) guidance reprinted from the CPA Letter, Special Supplement, dated February 10, 1986 (also referred to as Exhibit 1 to AcSEC Practice Bulletin No. 1). Additional interest earned on these higher risk loan transactions (as defined in the individual loan agreements) is recognized as realized under the provisions contained in AcSEC’s guidance reprinted from the CPA Letter, Special Supplement, dated February 10, 1986 (also referred to as Exhibit 1 to AcSEC Practice Bulletin No.1) and Staff Accounting Bulletin No. 101 (Revenue Recognition in Financial Statements). Certain additional interest is included as a component of noninterest income.  ECV had six higher risk lending transactions outstanding as of March 31, 2015, as compared to four higher risk lending transactions outstanding as of December 31, 2014, amounting to $12.0 million and $6.2 million, respectively.

 

Allowance for Credit Losses

 

The allowance for credit losses represents an amount which, in management’s judgment, is adequate to absorb probable losses on existing loans and other extensions of credit that may become uncollectible. The adequacy of the allowance for credit losses is determined through careful and continuous review and evaluation of the loan portfolio and involves the balancing of a number of factors to establish a prudent level of allowance. Among the factors considered in evaluating the adequacy of the allowance for credit losses are lending risks associated with growth and entry into new markets, loss allocations for specific credits, the level of the allowance to nonperforming loans, historical loss experience, economic conditions, portfolio trends and credit concentrations, changes in the size and character of the loan portfolio, and management’s judgment with respect to current and expected economic conditions and their impact on the existing loan portfolio. Allowances for impaired loans are generally determined based on collateral values. Loans or any portion thereof deemed uncollectible are charged against the allowance, while recoveries are credited to the allowance. Management adjusts the level of the allowance through the provision for credit losses, which is recorded as a current period operating expense. The allowance for credit losses consists of allocated and unallocated components.

 

The components of the allowance for credit losses represent an estimation done pursuant to ASC Topic 450, “Contingencies,” or ASC Topic 310, “Receivables.” Specific allowances are established in cases where management has identified significant conditions or circumstances related to a specific credit that management believes indicate the probability that a loss may be incurred. For potential problem credits for which specific allowance amounts have not been determined, the Company establishes allowances according to the application of credit risk factors. These factors are set by management and approved by the appropriate Board committee to reflect its assessment of the relative level of risk inherent in each risk grade. A third component of the allowance computation, termed a nonspecific or environmental factors allowance, is based upon management’s evaluation of various environmental conditions that are not directly measured in the determination of either the specific allowance or formula allowance. Such conditions include general economic and business conditions affecting key lending areas, credit quality trends (including trends in delinquencies and nonperforming loans expected to result from existing conditions), loan volumes and concentrations, specific industry conditions within portfolio categories, recent loss experience in particular loan categories, duration of the current business cycle, bank regulatory examination results, findings of outside review consultants, and management’s judgment with respect to various other conditions including credit administration and management and the quality of risk identification systems. Executive management reviews these environmental conditions quarterly, and documents the rationale for all changes.

 

 

Management believes that the allowance for credit losses is adequate; however, determination of the allowance is inherently subjective and requires significant estimates. While management uses available information to recognize losses on loans, future additions to the allowance may be necessary based on changes in economic conditions. Evaluation of the potential effects of these factors on estimated losses involves a high degree of uncertainty, including the strength and timing of economic cycles and concerns over the effects of a prolonged economic downturn in the current cycle. In addition, various regulatory agencies, as an integral part of their examination process, and independent consultants engaged by the Bank, periodically review the Bank’s loan portfolio and allowance for credit losses. Such review may result in recognition of additions to the allowance based on their judgments of information available to them at the time of their examination.

 

Premises and Equipment

 

Premises and equipment are stated at cost less accumulated depreciation and amortization computed using the straight-line method for financial reporting purposes. Premises and equipment are depreciated over the useful lives of the assets, which generally range from five to seven years for furniture, fixtures and equipment, to three to five years for computer software and hardware, and to ten to forty years for buildings and building improvements. Leasehold improvements are amortized over the terms of the respective leases, which may include renewal options where management has the positive intent to exercise such options, or the estimated useful lives of the improvements, whichever is shorter. The costs of major renewals and betterments are capitalized, while the costs of ordinary maintenance and repairs are expensed as incurred. These costs are included as a component of premises and equipment expenses on the consolidated statements of operations.

 

Other Real Estate Owned (OREO)

 

Assets acquired through loan foreclosure are held for sale and are initially recorded at the lower of cost or fair value less estimated selling costs when acquired, establishing a new cost basis. The new basis is supported by appraisals that are no more than twelve months old. Costs after acquisition are generally expensed. If the fair value of the asset declines, a write-down is recorded through noninterest expense. The valuation of foreclosed assets is subjective in nature and may be adjusted in the future because of changes in market conditions or appraised values.

 

Goodwill and Other Intangible Assets

 

Goodwill represents the excess of the cost of an acquisition over the fair value of the net assets acquired. Other intangible assets represent purchased assets that lack physical substance but can be distinguished from goodwill because of contractual or other legal rights. Intangible assets that have finite lives, such as core deposit intangibles are amortized over their estimated useful lives and subject to periodic impairment testing. Intangible assets (other than goodwill) are amortized to expense using accelerated or straight-line methods over their respective estimated useful lives.

 

Goodwill and other intangibles are subject to impairment testing at the reporting unit level, which must be conducted at least annually. The Company performs impairment testing during the fourth quarter of each year or when events or changes in circumstances indicate the assets might be impaired.

 

The Company performs a qualitative assessment to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If, after assessing updated qualitative factors, the Company determines it is not more likely than not that the fair value of a reporting unit is less than its carrying amount, it does not have to perform the two-step goodwill impairment test. Determining the fair value of a reporting unit under the first step of the goodwill impairment test and determining the fair value of individual assets and liabilities of a reporting unit under the second step of the goodwill impairment test are judgmental and often involve the use of significant estimates and assumptions. Similarly, estimates and assumptions are used in determining the fair value of other intangible assets. Estimates of fair value are primarily determined using discounted cash flows, market comparisons and recent transactions. These approaches use significant estimates and assumptions including projected future cash flows, discount rates reflecting the market rate of return, projected growth rates and determination and evaluation of appropriate market comparables. Based on the results of quantitative assessments of all reporting units, the Company concluded that no impairment existed at December 31, 2014. However, future events could cause the Company to conclude that goodwill or other intangibles have become impaired, which would result in recording an impairment loss. Any resulting impairment loss could have a material adverse impact on the Company’s financial condition and results of operations.

 

 

Customer Repurchase Agreements

 

The Company enters into agreements under which it sells securities subject to an obligation to repurchase the same securities. Under these arrangements, the Company may transfer legal control over the assets but still retain effective control through an agreement that both entitles and obligates the Company to repurchase the assets. As a result, securities sold under agreements to repurchase are accounted for as collateralized financing arrangements and not as a sale and subsequent repurchase of securities. The agreements are entered into primarily as accommodations for large commercial deposit customers. The obligation to repurchase the securities is reflected as a liability in the Company’s consolidated balance of sheets, while the securities underlying the securities sold under agreements to repurchase remain in the respective assets accounts and are delivered to and held as collateral by third party trustees.

 

Marketing and Advertising

 

Marketing and advertising costs are generally expensed as incurred.

 

Income Taxes

 

The Company employs the liability method of accounting for income taxes as required by ASC Topic 740, “Income Taxes.” Under the liability method, deferred tax assets and liabilities are determined based on differences between the financial statement carrying amounts and the tax basis of existing assets and liabilities (i.e., temporary timing differences) and are measured at the enacted rates that will be in effect when these differences reverse. The Company utilizes statutory requirements for its income tax accounting, and avoids risks associated with potentially problematic tax positions that may incur challenge upon audit, where an adverse outcome is more likely than not. Therefore, no provisions are made for either uncertain tax positions nor accompanying potential tax penalties and interest for underpayments of income taxes in the Company’s tax reserves. In accordance with ASC Topic 740, the Company may establish a reserve against deferred tax assets in those cases where realization is less than certain, although no such reserves exist at March 31, 2015, December 31, 2014, or March 31, 2014.

 

Transfer of Financial Assets

 

Transfers of financial assets are accounted for as sales, when control over the assets has been surrendered. Control over transferred assets is deemed to be surrendered when (1) the assets have been isolated from the Company, (2) the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets, and (3) the Company does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity. In certain cases, the recourse to the Bank to repurchase assets may exist but is deemed immaterial based on the specific facts and circumstances.

 

Earnings per Common Share

 

Basic net income per common share is derived by dividing net income available to common shareholders by the weighted-average number of common shares outstanding during the period measured. Diluted earnings per common share is computed by dividing net income available to common shareholders by the weighted-average number of common shares outstanding during the period measured including the potential dilutive effects of common stock equivalents.

 

Stock-Based Compensation

 

In accordance with ASC Topic 718, “Compensation,” the Company records as compensation expense an amount equal to the amortization (over the remaining service period) of the fair value computed at the date of grant. Compensation expense on variable stock option grants (i.e. performance based grants) is recorded based on the probability of achievement of the goals underlying the performance grant. Refer to Note 8 for a description of stock-based compensation awards, activity and expense.

 

 

New Authoritative Accounting Guidance

 

In January 2014, the FASB issued ASU No. 2014-01, "Accounting for Investments in Qualified Affordable Housing Projects." ASU No. 2014-01 permits reporting entities to make an accounting policy election to account for their investments in qualified affordable housing projects using the proportional amortization method if certain conditions are met. Under the proportional amortization method, an entity amortizes the initial cost of the investment in proportion to the tax credits and other tax benefits received, and recognize the net investment performance in the income statement as a component of income tax expense. This new guidance also requires new disclosures for all investors in these projects. The Company adopted ASU No. 2014-01 effective January 1, 2015. Upon adoption, the guidance must be applied retrospectively to all periods presented. However, entities that used the effective yield method to account for investments in these projects before adoption may continue to do so for these pre-existing investments. Prior to adoption of ASU No. 2014-01, the Company accounted for such investments using the effective yield method and continued to do so for these pre-existing investments after adopting ASU No. 2014-01. The Company expects future investments to meet the criteria required for the proportional amortization method and plans to make such an accounting policy election. There were no new investments made since the adoption of ASU No. 2014-01 on January 1, 2015, and therefore, the adoption of ASU No. 2014-01 did not have a material impact on the Company's Consolidated Financial Statements.

 

In January 2014, the FASB issued ASU No. 2014-04, "Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans upon Foreclosure." The objective of this guidance is to clarify when an in substance repossession or foreclosure occurs, that is, when a creditor should be considered to have received physical possession of residential real estate property collateralizing a consumer mortgage loan such that the loan receivable should be derecognized and the real estate property recognized. ASU No. 2014-04 states that an in substance repossession or foreclosure occurs, and a creditor is considered to have received physical possession of residential real estate property collateralizing a consumer mortgage loan, upon either: (1) The creditor obtaining legal title to the residential real estate property upon completion of a foreclosure; or (2) The borrower conveying all interest in the residential real estate property to the creditor to satisfy that loan through completion of a deed in lieu of foreclosure or through a similar legal agreement. Additionally, ASU No. 2014-04 requires interim and annual disclosure of both: (1) The amount of foreclosed residential real estate property held by the creditor; and (2) The recorded investment in consumer mortgage loans collateralized by residential real estate property that are in the process of foreclosure according to local requirements of the applicable jurisdiction. The Company adopted ASU No. 2014-04 effective January 1, 2015. The adoption of ASU No. 2014-04 did not have a material impact on the Company's Consolidated Financial Statements.

 

In August 2014, the FASB issued ASU No. 2014-14, “Classification of Certain Government-Guaranteed Mortgage Loans upon Foreclosure.” The objective of this guidance is to reduce diversity in practice related to how creditors classify government-guaranteed mortgage loans, including FHA or VA guaranteed loans, upon foreclosure. Some creditors reclassify those loans to real estate consistent with other foreclosed loans that do not have guarantees; others reclassify the loans to other receivables. The amendments in this guidance require that a mortgage loan be derecognized and that a separate other receivable be recognized upon foreclosure if the following conditions are met: (1) The loan has a government guarantee that is not separable from the loan before foreclosure; (2) At the time of foreclosure, the creditor has the intent to convey the real estate property to the guarantor and make a claim on the guarantee, and the creditor has the ability to recover under that claim; and (3) At the time of foreclosure, any amount of the claim that is determined on the basis of the fair value of the real estate is fixed. Upon foreclosure, the separate other receivable should be measured based on the amount of the loan balance (principal and interest) expected to be recovered from the guarantor. The Company adopted ASU No. 2014-14 effective January 1, 2015. The adoption of ASU No. 2014-14 did not have a material impact on the Company's Consolidated Financial Statements.

 

In April 2015, the FASB issued ASU No. 2015-03, “Interest—Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs.” The update simplifies the presentation of debt issuance costs by requiring that debt issuance costs be presented in the balance sheet as a direct deduction from the carrying amount of debt liability, consistent with debt discounts or premiums. The recognition and measurement guidance for debt issuance costs are not affected by the amendments in this update. This update will be effective for interim and annual periods beginning after December 15, 2015, and is to be applied retrospectively. Early adoption is permitted. The Company is currently assessing the impact that this guidance will have on its consolidated financial statements, but does not expect the guidance to have a material impact.

 

 

Note 2. Cash and Due from Banks

 

Regulation D of the Federal Reserve Act requires that banks maintain noninterest reserve balances with the Federal Reserve Bank based principally on the type and amount of their deposits. For the first quarter of 2015, the Bank maintained balances at the Federal Reserve sufficient to meet reserve requirements, as well as significant excess reserves. Late in 2008, the Federal Reserve in connection with the Emergency Economic Stabilization Act of 2008 began paying a nominal amount of interest on balances held, which interest on excess reserves was increased under provisions of the Dodd Frank Wall Street Reform and Consumer Protection Act passed in July 2010.

 

Additionally, the Bank maintains interest-bearing balances with the Federal Home Loan Bank of Atlanta and noninterest bearing balances with six domestic correspondent banks as compensation for services they provide to the Bank.

 

Note 3. Investment Securities Available-for-Sale

 

Amortized cost and estimated fair value of securities available-for-sale are summarized as follows:

 

						Gross					Gross				Estimated
March 31, 2015		Amortized				Unrealized					Unrealized				Fair
(dollars in thousands)		Cost				Gains					Losses				Value
U. S. Government agency securities		$	29,433			$	686				$	-			$	30,119
Residential mortgage backed securities			233,127				2,183					1,159				234,151
Municipal bonds			65,109				3,737					49				68,797
Other equity investments			396				68					-				464
		$	328,065			$	6,674				$	1,208			$	333,531

 

						Gross					Gross				Estimated
December 31, 2014		Amortized				Unrealized					Unrealized				Fair
(dollars in thousands)		Cost				Gains					Losses				Value
U. S. Government agency securities		$	29,434			$	500				$	40			$	29,894
Residential mortgage backed securities			241,120				1,716					2,516				240,320
Municipal bonds			106,983				4,850					121				111,712
Other equity investments			396				21					-				417
		$	377,933			$	7,087				$	2,677			$	382,343

 

 

Gross unrealized losses and fair value by length of time that the individual available-for-sale securities have been in a continuous unrealized loss position are as follows:

 

 

 

		Less than									12 Months
		12 Months									or Greater								Total
		Estimated									Estimated								Estimated
March 31, 2015		Fair					Unrealized				Fair				Unrealized				Fair				Unrealized
(dollars in thousands)		Value					Losses				Value				Losses				Value				Losses
Residential mortgage backed securities		$	13,798				$	35			$	76,319			$	1,124			$	90,117			$	1,159
Municipal bonds			5,620					49				-				-				5,620				49
		$	19,418				$	84			$	76,319			$	1,124			$	95,737			$	1,208

 

		Less than									12 Months
		12 Months									or Greater								Total
		Estimated									Estimated								Estimated
December 31, 2014		Fair					Unrealized				Fair				Unrealized				Fair				Unrealized
(dollars in thousands)		Value					Losses				Value				Losses				Value				Losses
U. S. Government agency securities		$	2,001				$	7			$	1,750			$	33			$	3,751			$	40
Residential mortgage backed securities			49,644					221				86,028				2,295				135,672				2,516
Municipal bonds			4,974					14				10,915				107				15,889				121
		$	56,619				$	242			$	98,693			$	2,435			$	155,312			$	2,677

 

 

The unrealized losses that exist are generally the result of changes in market interest rates and interest spread relationships since original purchases. The weighted average duration of debt securities, which comprise 99.9% of total investment securities, is relatively short at 3.8 years. If quoted prices are not available, fair value is measured using independent pricing models or other model-based valuation techniques such as the present value of future cash flows, adjusted for the security’s credit rating, prepayment assumptions and other factors such as credit loss assumptions. The Company does not believe that the investment securities that were in an unrealized loss position as of March 31, 2015 represent an other-than-temporary impairment for the reasons noted. The Company does not intend to sell the investments and it is more likely than not that the Company will not have to sell the securities before recovery of its amortized cost basis, which may be maturity. In addition, at March 31, 2015, the Company held $16.8 million in equity securities in a combination of Federal Reserve Bank (“FRB”) and Federal Home Loan Bank (“FHLB”) stocks, which are required to be held for regulatory purposes, and are not marketable.

 

The amortized cost and estimated fair value of investments available-for-sale by contractual maturity are shown in the table below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.

 

		March 31, 2015								December 31, 2014
		Amortized				Estimated				Amortized				Estimated
(dollars in thousands)		Cost				Fair Value				Cost				Fair Value
U. S. Government agency securities maturing:
One year or less		$	2,999			$	3,040			$	2,998			$	3,051
After one year through five years			19,940				20,381				19,947				20,276
Five years through ten years			6,494				6,698				6,489				6,567
Residential mortgage backed securities			233,127				234,151				241,120				240,320
Municipal bonds maturing:
One year or less			1,530				1,535				2,410				2,438
After one year through five years			33,513				36,084				47,038				49,607
Five years through ten years			27,505				28,373				54,983				56,927
After ten years			2,561				2,805				2,552				2,740
Other equity investments			396				464				396				417
		$	328,065			$	333,531			$	377,933			$	382,343

 

The carrying value of securities pledged as collateral for certain government deposits, securities sold under agreements to repurchase, and certain lines of credit with correspondent banks at March 31, 2015 was $256.6 million, which is well in excess of required amounts in order to operationally provide significant reserve amounts for new business. As of March 31, 2015 and December 31, 2014, there were no holdings of securities of any one issuer, other than the U.S. Government and U.S. Government agency securities, which exceeded ten percent of shareholders’ equity.

 

 

Note 4. Derivatives

 

As part of its mortgage banking activities, the Bank enters into interest rate lock commitments, which are commitments to originate loans where the interest rate on the loan is determined prior to funding and the customers have locked into that interest rate. The Bank then commits the specific loan for sale with an investor if and only if settlement occurs (“best efforts”) or alternatively commits to deliver the locked loan in a binding (“mandatory”) delivery program with an investor. Certain loans under interest rate lock commitments are covered under forward sales contracts of mortgage backed securities (“MBS”) which provides a hedge against interest rate changes between the time the individual loan interest rate is locked with the borrower and the time the loan is sold to the investor. Forward sales contracts of MBS are recorded at fair value with changes in fair value recorded in noninterest income. Interest rate lock commitments and commitments to deliver loans to investors are considered derivatives. The market value of interest rate lock commitments and best efforts contracts are not readily ascertainable with precision because they are not actively traded in stand-alone markets. The Bank determines the fair value of interest rate lock commitments and delivery contracts by measuring the fair value of the underlying asset, which is impacted by current interest rates, taking into consideration the probability that the interest rate lock commitments will close or will be funded.

 

Certain additional risks arise from forward delivery contracts in that the counterparties to the contracts may not be able to meet the terms of the contracts. The Bank does not expect any counterparty to any MBS to fail to meet its obligation. Additional risks inherent in mandatory delivery programs include the risk that, if the Bank does not close the loans subject to interest rate risk lock commitments, it may have a mismatch in its hedged position which could negatively impact earnings.

 

The fair value of the derivatives is recorded as a freestanding asset or liability with the change in value being recognized in current earnings during the period of change.

 

At March 31, 2015 the Bank had derivative financial instruments with a notional value of $62.4 million related to its forward contracts. The net fair value of these derivative instruments at March 31, 2015 was $219 thousand, which is included in other assets and $140 thousand included in other liabilities. There were no derivative instruments outstanding during the first quarter of 2014.

 

Included in other noninterest income for the three months ended March 31, 2015 was a gain of $30 thousand, relating to derivative instruments. The amount included in other noninterest income for the three months ended March 31, 2015 pertaining to its hedging activities was a gain of $171 thousand. There were no derivative instruments or hedging activities outstanding during the first quarter of 2014.

 

Note 5. Loans and Allowance for Credit Losses

 

The Bank makes loans to customers primarily in the Washington, DC metropolitan area and surrounding communities. A substantial portion of the Bank’s loan portfolio consists of loans to businesses secured by real estate and other business assets.

 

 

Loans, net of unamortized net deferred fees, at March 31, 2015, December 31, 2014, and March 31, 2014 are summarized by type as follows:

 

		March 31, 2015								December 31, 2014								March 31, 2014
(dollars in thousands)		Amount				%				Amount				%				Amount				%
Commercial		$	933,715				21	%		$	916,226				21	%		$	704,386				23	%
Income producing - commercial real estate			1,739,483				40	%			1,703,172				40	%			1,196,405				40	%
Owner occupied - commercial real estate			493,003				11	%			461,581				11	%			320,994				10	%
Real estate mortgage - residential			147,871				3	%			148,018				3	%			97,846				3	%
Construction - commercial and residential			862,013				19	%			793,432				18	%			593,967				19	%
Construction - C&I (owner occupied)			49,558				1	%			58,032				1	%			35,480				1	%
Home equity			120,543				3	%			122,536				3	%			108,839				4	%
Other consumer			98,707				2	%			109,402				3	%			6,058				-
Total loans			4,444,893				100	%			4,312,399				100	%			3,063,975				100	%
Less: Allowance for Credit Losses			(47,779	)							(46,075	)							(42,018	)
Net loans		$	4,397,114							$	4,266,324							$	3,021,957

 

Unamortized net deferred fees amounted to $15.8 million, $15.6 million, and $13.6 million at March 31, 2015, December 31, 2014, and March 31, 2014, respectively. 

 

As of March 31, 2015 and December 31, 2014, the Bank serviced $67.7 million and $67.9 million, respectively, of SBA loans which are not reflected as loan balances on the consolidated balance sheets.

 

Loan Origination / Risk Management

 

The Company’s goal is to mitigate risks in the event of unforeseen threats to the loan portfolio as a result of economic downturn or other negative influences. Plans for mitigating inherent risks in managing loan assets include: carefully enforcing loan policies and procedures, evaluating each borrower’s business plan during the underwriting process and throughout the loan term, identifying and monitoring primary and alternative sources for loan repayment, and obtaining collateral to mitigate economic loss in the event of liquidation. Specific loan reserves are established based upon credit and/or collateral risks on an individual loan basis. A risk rating system is employed to proactively estimate loss exposure and provide a measuring system for setting general and specific reserve allocations.

 

The composition of the Company’s loan portfolio is heavily weighted toward commercial real estate, both owner occupied and investment real estate. The combination of owner occupied commercial real estate and owner occupied commercial real estate construction represents 12% of the loan portfolio. At March 31, 2015, the combination of commercial real estate and real estate construction loans represents approximately 71% of the loan portfolio. When owner occupied commercial real estate and owner occupied commercial construction loans are excluded, the percentage of commercial real estate and construction loans to total loans decreases to 59%. These loans are underwritten to mitigate lending risks typical of this type of loan such as declines in real estate values, changes in borrower cash flow and general economic conditions. The Bank’s policy requires a maximum loan to value of 80% and minimum cash flow debt service coverage of 1.15 to 1.00. Personal guarantees are generally required, but may be limited.  In making real estate commercial mortgage loans, the Bank generally requires that interest rates adjust not less frequently than five years.

 

The Company is also an active traditional commercial lender providing loans for a variety of purposes, including working capital, equipment and account receivable financing. This loan category represents approximately 21% of the loan portfolio at March 31, 2015 and was generally variable or adjustable rate. Commercial loans meet reasonable underwriting standards, including appropriate collateral and cash flow necessary to support debt service. Personal guarantees are generally required, but may be limited. SBA loans represent 1% of the commercial loan category of loans. In originating SBA loans, the Company assumes the risk of non-payment on the unguaranteed portion of the credit. The Company generally sells the guaranteed portion of the loan generating noninterest income from the gains on sale, as well as servicing income on the portion participated. SBA loans are subject to the same cash flow analyses as other commercial loans. SBA loans are subject to a maximum loan size established by the SBA.

 

 

Approximately 5% of the loan portfolio at March 31, 2015 consists of home equity loans and lines of credit and other consumer loans, consisting primarily of indirect automobile loans acquired in the Merger. These credits, while making up a smaller portion of the loan portfolio, demand the same emphasis on underwriting and credit evaluation as other types of loans advanced by the Bank.

 

Approximately 3% of the loan portfolio consists of residential mortgage loans. These are typically loans underwritten to shorter terms, generally less than 10 years.

 

Loans are secured primarily by duly recorded first deeds of trust. In some cases, the Bank may accept a recorded junior trust position. In general, borrowers will have a proven ability to build, lease, manage and/or sell a commercial or residential project and demonstrate satisfactory financial condition. Additionally, an equity contribution toward the project is customarily required.

 

Construction loans require that the financial condition and experience of the general contractor and major subcontractors be satisfactory to the Bank. Guaranteed, fixed price contracts are required whenever appropriate, along with payment and performance bonds or completion bonds for larger scale projects.

 

Loans intended for residential land acquisition, lot development and construction are made on the premise that the land: 1) is or will be developed for building sites for residential structures, and; 2) will ultimately be utilized for construction or improvement of residential zoned real properties, including the creation of housing. Residential development and construction loans will finance projects such as single family subdivisions, planned unit developments, townhouses, and condominiums. Residential land acquisition, development and construction loans generally are underwritten with a maximum term of 36 months, including extensions approved at origination.

 

Commercial land acquisition and construction loans are secured by real property where loan funds will be used to acquire land and to construct or improve appropriately zoned real property for the creation of income producing or owner user commercial properties. Borrowers are generally required to put equity into each project at levels determined by the appropriate Loan Committee. Commercial land acquisition and construction loans generally are underwritten with a maximum term of 24 months.

 

Substantially all construction draw requests must be presented in writing on American Institute of Architects documents and certified either by the contractor, the borrower and/or the borrower’s architect. Each draw request shall also include the borrower’s soft cost breakdown certified by the borrower or its Chief Financial Officer. Prior to an advance, the Bank or its contractor inspects the project to determine that the work has been completed, to justify the draw requisition.

 

Commercial permanent loans are secured by improved real property which is generating income in the normal course of operation. Debt service coverage, assuming stabilized occupancy, must be satisfactory to support a permanent loan. The debt service coverage ratio is ordinarily at least 1.15 to 1.00. As part of the underwriting process, debt service coverage ratios are stress tested assuming a 200 basis point increase in interest rates from their current levels.

 

Commercial permanent loans generally are underwritten with a term not greater than 10 years or the remaining useful life of the property, whichever is lower. The preferred term is between 5 to 7 years, with amortization to a maximum of 25 years.

 

The Company’s loan portfolio includes ADC real estate loans including both investment and owner occupied projects. ADC loans amounted to $912 million at March 31, 2015. A portion of the ADC portfolio, both speculative and non-speculative, includes loan funded interest reserves at origination. ADC loans containing loan funded interest reserves represent approximately 37% of the outstanding ADC loan portfolio at March 31, 2015. The decision to establish a loan-funded interest reserve is made upon origination of the ADC loan and is based upon a number of factors considered during underwriting of the credit including: (i) the feasibility of the project; (ii) the experience of the sponsor; (iii) the creditworthiness of the borrower and guarantors; (iv) borrower equity contribution; and (v) the level of collateral protection. When appropriate, an interest reserve provides an effective means of addressing the cash flow characteristics of a properly underwritten ADC loan. The Company does not significantly utilize interest reserves in other loan products. The Company recognizes that one of the risks inherent in the use of interest reserves is the potential masking of underlying problems with the project and/or the borrower’s ability to repay the loan. In order to mitigate this inherent risk, the Company employs a series of reporting and monitoring mechanisms on all ADC loans, whether or not an interest reserve is provided, including: (i) construction and development timelines which are monitored on an ongoing basis which track the progress of a given project to the timeline projected at origination; (ii) a construction loan administration department independent of the lending function; (iii) third party independent construction loan inspection reports; (iv) monthly interest reserve monitoring reports detailing the balance of the interest reserves approved at origination and the days of interest carry represented by the reserve balances as compared to the then current anticipated time to completion and/or sale of speculative projects; and (v) quarterly commercial real estate construction meetings among senior Company management, which includes monitoring of current and projected real estate market conditions. If a project has not performed as expected, it is not the customary practice of the Company to increase loan funded interest reserves.

 

 

From time to time the Company may make loans for its own portfolio or through its higher risk loan affiliate, ECV. Such loans, which are made to finance projects (which may also be financed at the Bank level), may have higher risk characteristics than loans made by the Bank, such as lower priority interests and/or higher loan to value ratios. The Company seeks an overall financial return on these transactions commensurate with the risks and structure of each individual loan. Certain transactions may bear current interest at a rate with a significant premium to normal market rates. Other loan transactions may carry a standard rate of current interest, but also earn additional interest based on a percentage of the profits of the underlying project or a fixed accrued rate of interest.

 

 

 

The following tables detail activity in the allowance for credit losses by portfolio segment for the three months ended March 31, 2015 and 2014. Allocation of a portion of the allowance to one category of loans does not preclude its availability to absorb losses in other categories.

 

						Income				Owner				Real				Construction
						Producing Commercial				Occupied Commercial				Estate Mortgage				Commercial and				Home				Other
(dollars in thousands)		Commercial				Real Estate				Real Estate				Residential				Residential				Equity				Consumer				Total
For the three months ended March 31, 2015
Allowance for credit losses:
Balance at beginning of period		$	13,222			$	11,442			$	2,954			$	1,259			$	15,625			$	1,469			$	104			$	46,075
Loans charged-off			(998	)			(318	)			-				-				-				(419	)			(71	)			(1,806	)
Recoveries of loans previously charged-off			51				-				1				2				95				2				49				200
Net loans charged-off			(947	)			(318	)			1				2				95				(417	)			(22	)			(1,606	)
Provision for credit losses			1,502				528				172				(206	)			663				457				194				3,310
Ending balance		$	13,777			$	11,652			$	3,127			$	1,055			$	16,383			$	1,509			$	276			$	47,779
For the period ended March 31, 2015
Allowance for credit losses:
Individually evaluated for impairment		$	5,771			$	568			$	400			$	-			$	550			$	289			$	5			$	7,583
Collectively evaluated for impairment			8,006				11,084				2,727				1,055				15,833				1,220				271				40,196
Ending balance		$	13,777			$	11,652			$	3,127			$	1,055			$	16,383			$	1,509			$	276			$	47,779

 

						Income				Owner				Real				Construction
						Producing Commercial				Occupied Commercial				Estate Mortgage				Commercial and				Home				Other
(dollars in thousands)		Commercial				Real Estate				Real Estate				Residential				Residential				Equity				Consumer				Total
For the three months ended March 31, 2014
Allowance for credit losses:
Balance at beginning of period		$	9,780			$	10,359			$	3,899			$	944			$	13,934			$	1,871			$	134			$	40,921
Loans charged-off			(273	)			-				(35	)			(62	)			(581	)			(149	)			(25	)			(1,125	)
Recoveries of loans previously charged-off			211				-				-				-				65				5				7				288
Net loans charged-off			(62	)			-				(35	)			(62	)			(516	)			(144	)			(18	)			(837	)
Provision for credit losses			1,702				231				(669	)